UK economy faces 'huge challenge'

Economists predict difficult times for winner of UK election with country mired in debt.

05 May 2010 13:13 GMT

The next British government will inherit a faltering economy and spiralling public debts [EPA]

The outcome of Thursday's general election in the UK may be uncertain, but one thing the next government can be sure of is the scale of the economic challenge it faces.

The country's ailing economy has dominated the election campaign, with the rival parties vying to present themselves as best placed to lead Britain as it takes faltering steps out of recession.

The Labour government, led by Gordon Brown, says that the bank-bailout measures it took during the financial crisis helped avert an economic disaster that could have been far worse.

He may be right. But the bailout cost astronomical sums of money, and it was money that the UK did not have.

Dealing with the financial crisis and associated recession has prompted an increase in public borrowing on a scale not seen since the Second World War, ramping up the country's national debt to unprecedented levels.

With government borrowing now running close to 12 per cent of GDP, economists say that Britain has to start taking serious steps to reduce its budget deficit or risk losing investment from international financial markets.

Age of austerity

Analysts say that this election will mark the dawn of an era of austerity unlike anything seen in the country for a generation, with higher taxes and drastic cuts in public spending needed to fund efforts to balance the nation's books.

special report

But while the mainstream parties agree the current deficit level is unsustainable, there is only limited consensus on how best to achieve a reduction.

They all acknowledge the need to cut public spending, but they do not agree when, nor by how much.

The opposition Conservative party, currently leading in opinion polls, has said it would tighten public spending faster and more extensively than the other parties in an effort to reassure investors it is serious about slowing down Britain's rate of borrowing.

For their plan to work, economists say they will need to slash public sector spending by more than $90bn over the next five years.

Labour and the Liberal Democrats, the country's third-largest party, warn that spending cuts of this nature could plunge the UK into a "double-dip" recession, and have both outlined less severe programmes of cuts to be implemented over the same period.

But if there are risks in cutting too fast, many argue that not cutting enough could be equally disastrous.

If Britain is not seen to be dealing with its mountain of debt, the country could lose its triple-A credit rating and with it the trust of the financial markets whose investment in government bonds keeps treasury coffers full.

Huge challenge

If that happens, the results could be even more harmful than a recession sparked by spending cuts; demand for UK bonds could collapse and the UK could end up facing a Greek-style cashflow crisis.

Dr Andrew Hilton, director of the Centre for the Study of Financial Innovation, says that both approaches to dealing with the problem are fraught with difficulties.

"The next government will face a huge challenge," he says.

"If you move too fast you risk putting the economy into recession. If you move more slowly you risk the markets moving against you.

"They are really stuck between a rock and a hard place."

It is perhaps unsurprising then that none of the parties have fully explained where they are going to find the savings required for their deficit-reduction plans to work.

A report released by the Institute of Fiscal Studies (IFS) last week found that the cuts annouced by the Conservatives so far represent less than 18 per cent of the savings they will need to make to hit their reduced borrowing targets.

The cuts announced by Labour account for even less of the savings their plan requires - just 13 per cent of the total needed will be raised by cuts they have publicly identified.

The Liberal Democrats have been more forthcoming about how they will fund their plans, but have still identified only 25 per cent of the money they will need.

Vague plans

"It is striking how reticent all three main UK parties have been in explaining how they would confront the task," the IFS report noted. "Their public spending plans are particularly vague."

Gordon Brown's response to the financial crisis has ramped up Britain's public debt [EPA]

Mark Littlewood, the director of the Institute of Economic Affairs, argues that all three parties have failed to accept the extent of the problems facing the economy, which he says can only be solved by cutting back on spending far more aggresively than even the Conservative plan advocates.

"If the government was an individual human being, it would have maxed out the credit card," he says, arguing that the money that will be saved from planned "efficency savings" represents a drop in the ocean of what is required.

"If the UK economy was a patient, it would need a heart bypass operation," he says.

"The three main parties are arguing over whether it should take one aspirin or two, and whether it should take them today or tomorrow."

Part of the problem may be political, with none of the parties willing to risk votes by scaring the electorate over the scale of the forthcoming spending cuts.

Regardless, the next government will claim it has been mandated by the people to tackle Britain's growing mountain of debt.

The question is whether, when the austerity measures start to bite, the people agree.

Littlewood believes that public sector strikes are "quite likely" as the cuts kick in, and he is not alone in predicting political problems for the next goverment.

Mervyn King, the governor of the Bank of England, is said to believe that whoever wins this election will be out of power for a generation because of how tough the austerity measures will need to be.

On the eve of this hard-fought election, the message from economists is clear; the challenges posed by Britain's national deficit mean that the party leader who comes out on top on May 6 is likely to find exercising power even more difficult than winning it.